Contractors celebrating an important IR35 status victory in the Novasoft case are being warned that this “staggering” contractor win is likely to be overturned when, as expected, the case is appealed by HMRC.

At the possible end of an eight-year battle to prove he was outside IR35 during a 2002 contract, IT contractor Novak Brajkovic has won his appeal against HMRC’s Regulation 80 Income Tax and Section 8 National Insurance Contributions (NICs) notices to his contractor limited company, Novasoft Ltd.

The IR35 expert says: “This ruling flies in the face of previous rulings and all that we know about status cases. Oddly, this judge weighed the facts and came to a staggering conclusion. The majority of judges would not have come to the same conclusion and I would be amazed if the ruling was not overturned on appeal.”

ContractorCalculator CEO and Editor in Chief Dave Chaplin agrees: “I’ve read the ruling several times and, based on ten years of following IR35 cases, I cannot see how the judge ruled in the contractor’s favour. I’ll be very surprised if HMRC does not appeal, but also very happy. That’s because it will set some great precedents helping contractors stay outside of IR35.”

Part and parcel or control?

Turning to the background to the case, Vessey explains some of the case history. The principles laid down in the Ready Mix Concrete case, which are behind 90% of status cases, require that all three of the following conditions of a hypothetical employment contract be met:

There must be no other terms inconsistent with a contract of employment.

“In his ruling, Tribunal Judge Peter Kempster systematically examined each of the employment/self-employment indicators,” continues Vessey. “He found that the contractor was outside IR35 by virtue of his not being considered part and parcel of his client’s organisation.”

However, as reported in an interview published on AccountingWeb, it was contractor Brajkovic’s view that, “…the outcome of his appeal probably came down to the control factor and what he thought was the absence of the mutual obligations that employees enjoyed.”

Overturned on appeal

Vessey maintains that part and parcel is generally considered a minor status indicator and, although delighted for the contractor at this result, does not feel the ruling is reliable. He believes that, as with the Tilson case in 2009, it will be overturned on appeal.

“It’s not yet known whether HMRC will pursue the case further,” says Vessey. “But looking at all the comments made by the Judge as he systematically reviewed each status test, it is hard to escape the conclusion that the contractor should have been found inside IR35.”

It does appear the case would be likely to go HMRC’s way at appeal: the ruling confirmed evidence suggesting that Brajkovic had no right of substitution; his contract included a control clause and was for personal service; and there was mutuality of obligation. But representing himself at the Tribunal, Brajkovic countered HMRC’s arguments with a raft of evidence pointing away from him being part and parcel.

Looking at all the comments made by the Judge as he systematically reviewed each status test, it is hard to escape the conclusion that the contractor should have been found inside IR35

Andy Vessey, Qdos Consulting

Avoid HMRC’s contract review service

Brajkovic came into HMRC’s radar when he asked for a contract assessment from the then Inland Revenue’s advice service. At that time, in 2002, IR35 was relatively new and it may have seemed like a reasonable course of action. But in his interview with AccountingWeb, Brajkovic is quoted as now saying: “…I definitely would not use the HMRC advice service.”

But today, Vessey likens asking for a review to waving a flag saying ‘please come and investigate me!’. “The contractor and HMRC disagreed about the status of the contract and within two months Brajkovic found himself under IR35 investigation. Then in 2005 he received a notice from HMRC demanding £49,000 in income tax and NICs.”

ContractorCalculator’s Chaplin warns contractors to examine their insurance cover urgently: “What this case highlights is that tax investigation insurance is essential for any contractor. Because this insurance comes as a perk of membership with a number of trade bodies and is readily available from specialist consultants, cost should be no barrier to any contractor being able to mount an effective defence.”

Vessy says that HMRC has 56 days to appeal the decision, which brings the deadline to 1st June 2010. He concludes: “For the contractor’s sake, I hope that HMRC will take no further action; but sadly I expect to see Novasoft in the news again over the summer.

“If HMRC choose not to act that’s great news for Brajkovic, but will have little impact on other contractors’ IR35 cases that will still be determined by key precedents such as ‘Ready Mixed Concrete’.”

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